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How to calculate Customer Value?
Customer Lifetime Value
Customer Lifetime Value is a crucial indicator for any company. It allows us to make important decisions about sales, marketing strategies, products to promote and prioritize the service and attention to consumers.
Knowing what your customers are worth in a customer-centric strategy is essential to learn more about strengthening long-term relationships.
Customer Lifetime Value: Definition
Customer Lifetime Value is the profitability or income that a customer brings to the company throughout its relationship. You should remember that this type of classification by value is different from the market segmentation that we do in marketing because it is made based on the purchases that a customer has made in your company.
Therefore, the Customer Lifetime Value of the client indicates the benefit that that client brings you so far. For example, imagine that your client has been with you for three years with purchases worth € 500 / year. So far, it has brought us an income of € 1,500. That would be current revenue and would represent the value of that existing customer.
But, we can also extrapolate that current income level and calculate the future benefit that that client will report to you. Let’s imagine that the average customer turnover is five years. Going back to the previous example, that client still has two more years left and therefore € 1000 more in income. It would be the customer lifetime value or customer lifetime value.
What is a Customer’s Value used for?
The calculation of the value of customers is widely used to estimate the cost of acquisition (CPA) and determine the viability of projects.
For example, going back to the last model, my client’s first purchase may be less than what it cost me to attract him, and he has made the first sale at a loss. But suppose I know that the value of a customer over the average lifetime of the relationship will generate more profits. In that case, I can afford a higher acquisition cost since its importance goes beyond the first purchase. Of course, once he becomes a customer, you will have to take good care of him to repeat with future purchases.
Customer Lifetime Value, It also allows you to create your ABC of most valuable customers classifying them by profitability or income and thus help in the distribution of the commercial team. For example, I assign the highest value A customers to the best salesperson in my company. Finally, as you will see later in the article, knowing the most valuable customers will always allow you to prioritize resources, commercial and marketing actions over those customers that bring you the most value.
How do you calculate customer value? Example?
➤ Customer value calculation. Example 1
Customer Lifetime Value, Considering the previous example, it is easy to calculate what the client is worth, knowing that in the last three ages, they have spent about € 1,500. Customer value = € 1500/3 = € 500. Calculating the value of your clients in this way can be a mistake because we are only taking into account income and not benefits that it reports to us. A customer who buys me products with a certain profit margin is worth much more than a customer who buys me a lot of a product with little profit.
Therefore, we must calculate the benefits. Let’s imagine that those € 1,500 of income for that client from the last three years are distributed as follows:
- [Year 1 -> € 300]
- [Year 2 -> € 500]
- [Year 3-> € 700]
The final profit will depend on the margin that each of the products has.
Profit = (income-cost); Cost = fixed expenses + variable expenses
The value of the client will be determined by the average profit obtained in the last three years. (You could calculate the clients’ lives for the last 2 or 5 years if you prefer).
Customer value = [Profit (year1) + Profit (year2) + Profit (year3)] / 3
Customer value calculation. Example 2
Customer Lifetime Value, It is also exciting to calculate the average customer value of your business. Before, define a specific period T to measure the averages; this time can be from the last year or the previous 2 or 3 years.
It must also be clear how many customers enter the evaluation for the calculations. I mean whether they contain those who have bought or not in the last year or it is done for an exact segment. The measures are as follows:
- Average purchase value (VCP). It mentions the average purchase value that each customer types in your business. It calculates by distributing the total entered through the last year by the number of purchases made for all customers.
- Purchase frequency rate( TFC). It mentions the number of orders in the chosen period. The total number of buying made divides by the total number of customers.
- Now, grow the VPC by the TFC to obtain the Average Customer Value or Customer Value (CV) = VCP x TFC.
It is exciting to achieve the calculation by segments to compare them.
How to use the customer value calculation?
In addition to specifying your most valuable customers, this metric will also be helpful for:
- Segment your client portfolio based on the benefit that each segment brings you.
- Determine what the investment is according to the return you hope to obtain.
- Estimate growth and expansion projections based on calculating the future value of the customer.
- Determine the value of a company according to the sum of the importance of all its customers. If you want to delve into this aspect, you could inquire about how to calculate the value of a company.